The news of Japanese Finance Minister’s resignation could perhaps have one thinking that dire economic conditions of Japan must be the reason why he has to resign.

But apparently, that’s not the case. Mr. Nakagawa will resign for his drunk blurt at the press conference that left everybody in state of shock. The only other thing, which would qualify as worse than what he did, is coming out naked for the press conference.

I know it is too late to blog on Davos, yet I don’t want to miss it altogether.

World Economic Forum was held in Davos in January’09 and details of Davos tidbits could be found on FT’s Davos blog

Various voices emerging out of Davos were,

1. China and Russia attacked west for the bad economic management. Apparently, these same people were not bothered when they were building their surplus by manipulating currency exchange rates and kending money to US to buy stuff from them.

2. Several economists did not like the idea of ‘bad bank’, while politicians lead by Mr. Brown continued their effort to sell the bad idea of bad bank.

3. Davos should be known for rather conspicuous absense of big players from Uncle Sam’s team.

A hyperpower’s place is in the wrong. This is particularly true when, as last week at the annual meeting of the World Economic Forum in Davos, the hyperpower in question is barely represented, at least at the official level. But, truth to tell, the critics of the US – led by prime ministers Wen Jiabao of China and Vladimir Putin of Russia – had an easy story of incompetence and malfeasance to tell.

Yet, however easy it may be to blame the US for the current global economic woes, it is also to the US that the world looks for a solution.

The general mood in Davos was one of gloom verging on despair. The gloom is justified, as the update of the World Economic Outlook from the International Monetary Fund makes plain. Global economic growth is now projected to fall to a mere ½ per cent this year, its lowest rate since the second world war. Output in high-income countries is expected to fall by 2 per cent, the first annual contraction since 1945. Industrial production and merchandise exports are in free fall, as consumers decide they do not need that new car or other goody right now (see charts).

Given the rate at which they have been downgraded, reality could be far worse even than these forecasts. The global downward spiral of uncertainty, caution and cutbacks in lending and spending may continue. Alternatively, policy action may turn the ship around. But that action must be decisive. This is particularly true for the Obama administration, on which so much depends. It has a golden opportunity to reverse the spiral now. After that it becomes part of the problem. So far the evidence is discouraging. It should be far bolder.

Not all news is dreadful. Spreads between expected official interest rates and those on inter-bank lending have fallen sharply; those between US Treasury bonds and risky assets are also easing, though they remain at very high levels. The decline in oil prices represents a huge shift in income from savers to spenders. Since today’s collapse in demand and output is the lagged result of past disruption, better news may lie ahead.

Alas, such optimism must be kept in check. As the update of the IMF’s Global Financial Stability Report notes: “Worsening credit conditions … have raised our estimate of the potential deterioration in US-originated credit assets … from $1.4 trillion in the October 2008 GFSR to $2.2 trillion.” Losses are also spreading to many other asset classes and economies as the slump worsens.

Private credit growth is falling across most economies. Trade finance has been particularly affected, with dire results. The flow of private funds to emerging economies is collapsing: according to the Washington-based Institute for International Finance, net private flows are projected to be just $165bn in 2009, down from $466bn in 2008. Central and eastern Europe is particularly vulnerable.

Protectionist pressures are rising rapidly, not only in finance, but in trade. On the former, Gordon Brown, UK prime minister, turned up in Davos as hypocrite-in-chief, bemoaning the rise of the financial protectionism his own government has been practising. On the latter, nothing can surpass the folly of the Buy America provision in the draft US stimulus package. This is an invitation to retaliation. For a country that must export its way out of its slump, this is mad. For one that made an open global economy the keystone of its foreign policy for two generations, it is vandalism. Is this the change we must believe in?

Contrary to views expressed in some circles, notably in the US, depressions are neither good for us, nor unavoidable. What is needed is determined and globally co-ordinated action. The lead must come from the US: it remains the hyperpower; the economic system is one it promoted; and the crisis had much to do with mistakes its policymakers and private institutions made, even if aided and abetted by mistakes elsewhere.

So what are the principles to be followed? I suggest the following:

First, focus all attention on reversing the collapse in demand now, rather than on the global architecture.

Second, employ overwhelming force. The time for “shock and awe” in economic policymaking is now.

Third, make future normalisation of fiscal and monetary policies credible.

Fourth, act in concert. Even the US cannot solve its problems alone.

Fifth, avoid protectionism.

Sixth, strengthen the ability of global institutions to help the weaker.

So how are we doing against these standards? “Better than in the 1930s” is the best one can say. The world desperately needs Mr Obama to take a firmer grip at home and lead abroad. The plans he is now announcing give him a chance of doing the former. The April summit of the Group of 20 countries, in London, is his chance for achieving the latter.

Unfortunately, what is coming out of the US is desperately discouraging. Instead of an overwhelming fiscal stimulus, what is emerging is too small, too wasteful and too ill-focused. Instead of decisive action to recapitalise banks, which must mean temporary public control of insolvent banks, the US may be returning to the immoral and ineffective policy of bailing out those who now hold the “toxic assets”. Instead of acting as a global leader, there is resort to protectionism and a “blame game”.

This way lies a catastrophe. I expect little enlightenment from the rest of the globe: the European Central Bank is allowing the eurozone to collapse into deep recession; Japan is in meltdown; China has at least announced a big stimulus package, but it lacks a credible plan for needed structural reforms; and most other emerging countries can only try to stay afloat in these storm-tossed seas. Their accumulated foreign currency reserves of the 2000s will help. But the resources available to the IMF, even with their hoped-for doubling, are too small to give most emerging economies the confidence they need to risk keeping their spending up.

Decisions taken in the next few months will shape the world for a generation. If we get through this crisis without collapse, we will have the time and the chance to construct a better and more stable global order. If we do not, that opportunity may not recur for decades.

We are living on the cusp of history. The priority is to reverse the downward spiral of despair through overwhelming and concerted action. That will only occur if the US now gives the leadership we need. Mr Obama may even find, as many presidents have found before him, that leading the world is easier and more rewarding than cajoling a recalcitrant Congress. This may not be the challenge he expected. But it is the challenge he confronts. History will judge his presidency on whether he dares to succeed.

“There comes a time in every economic crisis or, more specifically, in every struggle to recover from crisis, when steps up to the podium to promise the policies that – they say – will deliver you back to growth. The person has political support, a strong track record, and every incentive to enter the history books. But one nagging question remains. Can this person, your new economic strategist, really break with the vested elites that got you into this much trouble?”Simon Johnson, professor economics at MIT, former chief economist IMF

Here is the clip of Simon Johnson discussing banking crisis with Bill Moyers.

One of the main culprit of subprime mortgage collapse was principal-agent problem.

For bankers, incentive to cheat and make a quick buck in bonuses was much larger than incentive to earn steady and secure profits for shareholders. There hasn’t been enough discussion surrounding this important area.

Free Markets can work, only if free markets can devise an effective remedy to principal-agent problem. If not, effective regulation is the only alternative.

Bad bank? Hmmm .. bad bank! How good can it be, when they name it bad bank?

What is Bad bank?

‘Bad Bank’ is the new gimmick tossed around by the same people who came up with but could not work out TARP – Troubled Assets Relief Program. The same set of intellientia has rebranded TARP as ‘Bad Bank’ and is running around proselytizing people to their newly formed faith – born again TARP.
“Bad Bank’ aims at isolating toxic trash from banks’ assets and create a new giant bad bank to carry only this toxic junk. This will improve the quality of asset book of all the banks and they will be back in their usual business of lending again. Good thought. So where is the problem?
The problem is, who will provide the capital for ‘Bad Bank’? Since most of the assets that are going to end up on the balance sheet of Bad Bank are worth nothing, they are essentially going to eat up most of the capital. So in the name of which crazy f*ing variant of capitalism, is it fair to ask taxpayers to cough up the capital for ‘Bad Bank’? They call it Lemon Socialism. I am no fan of socialism, but pure socialism is million times better than this Lemon Socialism.
The idea of ‘Bad Bank’ is going to fail for exact same reason the original idea of TARP failed. How to price the Toxic Assets? If they are priced at what they are worth i.e. zero, no bank will be willing to part them from their balance sheets. If they are priced anywhere near their book value, it is really bad deal for taxpayers.

Let’s look at what are the general perspectives we get to hear about Bad Bank.

The smart ones …

These people are the founding fathers of Bad Bank initiatives – the shrewd class of diplomats in cahoots with nation’s bankers. They have their own interests in getting things running again – even if it comes at the cost of taxpayer dollars. They want to sell this idea of Bad Bank somehow, because it is one perfect medicine that will mop up all the dirt from balance sheets of all banks. the ultimate cleansing of body and soul, you see.

The naive ones …

There are always few who fall for such cunning ideas of political craft. They say that toxic assets are in reality worth more than what they sell for in the market. So if gov’t sits over these assets for long duration, taxpayers will end up making profit on in. Okay. So markets don’t know how to price these assets, eh? But wait a minute, markets are supposed to know the best, isn’t it? Yes, and they do. These assets are really worth nothing.

The wise ones …

This includes economists like Joe Stglitz , Paul Krugman and Yves Smith, who openly criticized the idea of Bad Bank in its current form – just because it is exactly what it says it is .. Bad.

Firstly, I would like to apologize to myself for not doing recap for two weeks. Aniket, don’t be such a bum ass sloth. Secondly, I would also like to apologize to rest of the world for mostly focusing only on US in this crisis diary. But then, this crisis mainly revolves around US (..and I have better access to news and blogs out of US ), so you should not complain rest of the world. For time being we must pay attention to this big bogey bummer and straighten him up first. Hey, don’t complain. You had a chance to decouple. But instead, you decided to couple more and more. Now you are suffering from some serious STDs, not my fault, okay?

The two most important developments of last two weeks were Obama’s stimulus plan and ‘bad bank’ idea gathering momentum. But we shall deal both of them separately. Also, Davos deserves its own space. So let’s look at the rest of the news.

Market Update

When markets come to terms with reality they go down, when Mr. Obama shows his mug on TV and injects new hope they go up again. So new trade is – buy on hope, sell on reality.

Some good news out of the equity markets was the earlier November lows are still intact. Earnings season on Wall st was mix bag. Several technology companies incl. AAPL, IBM, HPQ surprised on the upside. Among industrial names CAT surprised on downside, while X declared decent numbers. Financials continue to struggle badly. Overall, earnings underscored one important fact – rest of the world is somewhat isolating itself from the worries of financials and housing.
Bond markets showed significant trend. 10-yr treasury yields increased significantly and so were the increase in TIPS spread, decrease in TED spread, decrease in commercial papers spread. These are the signs of easing credit crunch, diminishing deflation worries. Also Gold went up by more than 10% (840$/toz to 930$/toz) in last couple of weeks. This is perhaps all-time high for gold in many other currencies considering recent US$ appreciation. What does the gold movement mean? Inflation protection or safe(st) haven (with rapidly declining safe haven status of US$).

Crisis Watch for the week

TED is still signaling easing credit crunch and that is a very good news.TED spread 0.95
S&P: 825.88 (-2.7%)
VIX: 44.84 (-2.00%)

Here is a great blogpost by Brad Setser explaining China America relationship and how the interests of the two economies are diverging.

Three final observations:

1) The US needs financing, but China also needs markets for its exports. The “balance of financial terror” is such that China cannot reduce its financing of the US without also reducing the market for its exports. That limits China’s options. My own guess is that China is more constrained than in the past, as it presumably doesn’t want to do anything with its reserves that would add to the global slump in demand for Chinese goods. If hot money outflows subside, China will almost certainly need to continue to add to its reserves. And China’s ability to shift its reserves from dollar to the euro is also constrained by its desire to maintain good relations with its European trading partners. Key eurozone countries wouldn’t appreciate a big euro rally right now induced by a surge in Chinese purchases, especially if China maintained its dollar peg during the process.
2) China’s currency has appreciated significantly in real terms even as the pace of its appreciation against the dollar has slowed. That implies more not less friction between the US and China. China was willing to allow the RMB to go up against the dollar when the dollar was going down against other currencies and other countries were snapping up more Chinese goods. Now that the dollar is going up and Chinese exports are going down, China is reluctant to allow the RMB to appreciate at all against the dollar. But the US naturally cares far more about the RMB’s value against the dollar than its value against other currencies.
3) Even though China’s currency has appreciated significantly in real terms recently, most real exchange rate indices put it only a bit above its levels in 2000. The expansion of China’s current account surplus since then – and the huge increase in China’s exports since then — suggests that the RMB remains fundamentally undervalued. Other Aisan countries exports are actually falling faster than China’s exports. But the RMB’s real appreciation clearly came at a less than opportune time. The RMB was weak in real terms when China’s domestic economy was strong, and now it is getting stronger when China’s domestic economy is slowing sharply.

The US — a large deficit country — would benefit in a lot of ways if it could export its way out of trouble. That would also help to bring the world closer to balance. Yet with its own economy slowing sharply, China’s willingness to accept a stronger RMB has likely gone down. Here, US and Chinese interests diverge. Both want to draw on external demand to support their own growth.

Fortunately it is a littler harder to see why China would think that a major fiscal stimulus isn’t in its interests …

What’s been disturbing, however, is the parade of first-rate economists making totally non-serious arguments against fiscal expansion. You’ve got John Taylor arguing for permanent tax cuts as a response to temporary shocks, apparently oblivious to the logical problems. You’ve got John Cochrane going all Andrew-Mellon-liquidationist on us. You’ve got Eugene Fama reinventing the long-discredited Treasury View. You’ve got Gary Becker apparently unaware that monetary policy has hit the zero lower bound. And you’ve got Greg Mankiw — well, I don’t know what Greg actually believes, he just seems to be approvingly linking to anyone opposed to stimulus, regardless of the quality of their argument.

Meanwhile, it’s getting really ugly out there in economic environment. In sudden change of weather, sky is all covered with dark clouds, as if heavy pouring is going to start any minute.
I’m getting really really bad feeling that something sinister is about to happen.

Please, oh good Lord, please have some mercy! This is how Mr. Helicopter Ben is praying these days.
Imagine this. Ben is sitting at the Fed window (yes, the same window which he opened for every crook on the street last year) and CEOs of AIG, Big-3, Citi, BofA, WF et al are waiting in the queue for their turn. Everybody takes his turn, gulps down few billions of taxpayers’ money and goes back to stand at the end of the queue waiting for his next turn. The line never ends. Ben is printing money which evaporates at a rate faster than the rate at which any Obama-supporting group fills up on facebook. And where does this money go? Mostly in further writedowns and in executive compensations aka retention bonuses.

Glass is neither half full nor half empty. It is completely empty and broken. No matter how much water you pour in it , glass stays empty .

Bailout and more bailouts

Bailout saga returned last week. Gov’t bailed out BofA in much the same fashion as it did Citi a month back.

Bank of America announced the results hours after it won $20 billion in new capital from the government’s $700 billion Troubled Asset Relief Program (TARP).

Won? I did not understand what CNBC meant by that. So when you lose money and go begging, you win. Nice. Heads I win, tails you lose. Socialize losses, privatize gains. Well played capitalism! I don’t think I am a lefty. But I believe if gov’t must bailout these banks, gov’t should at least punish common-stock holders and management for their sloppy handling.

“It’s one of the first steps toward some positive news and the end of this nightmare,” said Michael Holland, founder of Holland & Co in New York, which manages more than $4 billion of investment

I agree.

On the similar lines, uncle Sam is planning to create big giant state-owned bad bank for everyone to dump their garbage. This is return of TARP. TARP has already used more than half of its allocated money and hardly any of it went to buying troubled assets, which was the original objective of TARP. TARP-phase 1 was more of a Troubled Bank Capitalization Program.

Paul Krugman (here and here), who always argued for capitalization and gov’t equity stake in troubled banks, did not like the new ‘bad bank’ idea a bit. In his compelling argument he says,

I suspect, though I’m not certain, that policymakers are once more coming around to the view that mortgage-backed securities are being systematically underpriced. But do we really know this? And how are we going to ensure that this doesn’t end up being a huge giveaway to financial firms?

I’m not dead set against this proposal — but I’m still waiting for some explanation of why this is supposed to be more than rearranging the deck chairs on the Titanic.

To answer Paul’s question on giveaway, no sir, we are worried at this point if it is a giveaway to banks. The financial markets are in crisis and this is the only way stock market can go up and continue to go further up. We are not worried about taxpayers at the moment, next elections are not due for another four years.

The bad bank plan has climbed the political agenda in the past couple of weeks as the Government has become aware of the extent of the lenders’ bad debts.

Sources said that a bad bank would have to take on about £200 billion of toxic assets. That would take the Government’s total commitment to solving the banking crisis to almost £1 trillion in taxpayers’ money that has either been spent or pledged.

That equates to about £33,000 per taxpayer. The total sum is equivalent to more than two-thirds of Britain’s annual GDP of £1.4 trillion.

The £1 trillion figure includes the £500 billion announced in October to buy shares in the banks and to guarantee their debt. It also includes a further £100 billion fund, which will also be announced next week as part of the rescue package, to provide the banks with cash to lend to ordinary customers and businesses.

As well as creating a bad bank, the Government is planning to use Northern Rock as a “good bank” which can dramatically increase lending to individuals and businesses.

During initial days of TARP, US followed UK’s idea of capitalizing banks instead of buying sh!t. Now UK wants to follow US idea of bad bank. What gives?

Oil Contango

What’s the deal with oil? Why such contango? Are all arbitrageurs dead? Nobody has any money to lend even when clear risk-free opportunity of making a quick buck is staring in the face?

Mark Thoma posted this puzzle on this blog. IMO, the winner is ‘Counter-party risk’.

The entire idea of ‘bad bank’ is also aimed at bringing trust back to the system. Just the problem is how to effect the idea of bad bank making sure that everyone gets the fair deal.

Crisis Watch for the week

In the good news, TED continues to improve. In the bad news VIX and S&P are catching cold. Will TED follow thru?TED spread 1.03
S&P: 850.12 (-4.5%)
VIX: 46.11 (+10.00%)

About

08 November 2008
——————–
It’s 08Nov08 today. The financial crisis, which started with housing meltdown in US, has unfolded itself massively on global scale. This diary is an attempt to present the events as and when they happen from now onwards. I will try to keep it as factual as possible and looking to update it at least once in a week.
I am not an economist, so hoping to get layman’s common sense perspective on events of the crisis.
Crisis Diary as it unfolds …